Aruba, April 12, 2012 - The reality is that a significant part of China's growth since 2007-08 has been an illusion. Its headline growth of 8-10 per cent since then has been driven by new lending averaging 30-40 per cent of GDP. Up to 20-25 per cent of these loans may prove to be non-performing, amounting to losses of 6-10 per cent of GDP. If these losses are deducted, Chinese growth is much lower.

Unfortunately, China now faces significant problems in maintaining its high-growth strategy. In 2009, the Premier, Wen Jiabao, admitted that the "stabilisation and recovery of the Chinese economy are not yet steady, solid and balanced".
The case for a soft landing assumes that the investment and property bubbles are less serious than thought. Beijing has sufficient financial capacity to boost growth by loosening monetary policy and bank lending, while adjusting specific policies, such as lifting restrictions on housing sales to prop up prices. China is able to boost domestic consumption, replacing investment as the key driver of its economy. Excess capacity is gradually absorbed as the world economy recovers. Growth comes down gradually, without causing social and political disruptions.

The case for a hard landing assumes the rapid and destructive unwinding of asset price bubbles and problems within the Chinese banking system. A poor external environment and losses on foreign investment exacerbate the problem. Growth collapses, triggering massive social unrest and political tensions.